Description

At 9x next year's estimates Steiner Leisure is a cheap investment. Obviously it has some controversy swarming around it involving Princess' decision to attempt an in-house operation, but with is near monopoly position in the industry of running luxurious spa operations aboard all of the major cruise lines in existence, Steiner Leisure adds value. The primary investment thesis is that the constant worry of the "in-house" strategy being adopted by other cruise lines is over-blown and has resulted in a cheap stock.

Despite its lock as the only major operator in this niche business, it faces some issues that have recently driven Steiner’s stock price to levels that we feel are below it true worth. Steiner sells around $275 million worth of services (massages, manicures, facials, etc.) and products (ointments, creams, facial scrubs, etc.). About 60%+ of its sales occur within its cruise division with the remainder of sales coming from its expanding “resort spas” division.

The basic business plan is to provide its service to a captive audience aboard cruise ships and resorts in a way that enhances the overall experience of the vacationer. While seemingly a simple business to operate, it takes a great deal of logistical expertise from the recruiting, training and hiring of the staff to the product manufacturing and marketing.

Nearly 30% of Steiner’s sales are of their private labeled products and their ability to manufacture and sell them profitably is critical to the overall economics of the business. To make matters more complicated, the 8 month tours of hard duty for the staff tends to produce extremely high turnover rates. What seems like an attractive opportunity to do manicures in tropical locations turns into a 10-hour work days only to retire to cramped quarters to get a little rest for the next day at sea. To handle these types of operational challenges, it takes a great deal of organizational experience and human resource management.

Steiner has been in this business for a long time and has seen competitors come and go. In fact, a number of direct competitors have folded up shop or sold out to the survivor, Steiner itself. This industry consolidation and shakeup has literally left only Steiner standing.

But their position isn’t completely rosy. Steiner has to “rent” space from the cruise lines. There facilities are located on extremely valuable real estate aboard the ships and as such, it costs Steiner around 50% of its revenues just to be there. It works like this: a captive audience with money and time on their hands is delivered by the cruise line to a Steiner-operated spa and in return, the cruise line gets paid a healthy fee without the operating hassles. Of course they always want more and aren’t afraid to ask during each contract renewal bargaining session.

What has driven the stock to bargain levels?

Princess Cruise Lines (recently purchased by the bigger Carnival Corp.) has 10 ships currently under contract with Steiner. Princess just publicly announced that they will begin pilot testing an “in-house” spa operation aboard, not just one newly minted ship as expected, but aboard two new ships. This news sent Steiner’s stock plummeting over 30%.

These two new ships are not covered under the old Steiner contract and this move by Princess represents a potentially ominous competitive threat to Steiner’s position. The big fear isn’t about these two Princess ships, nor is it about the ten other Princess ships that are under contract renewals with Steiner in late 2004. The real fear is that Princess’ parent company and Steiner’s largest customer, Carnival Corp., will consider an “in house” strategy as well upon its contract expiration at the end of 2005.

This threat has always existed for Steiner and, in fact, Carnival and Royal Caribbean (its other big customer) have each tried “in house” spa operations. Attempts by both cruise lines failed so miserably in the early and mid ‘90s that both have all but sworn off the whole concept. But, likely as a strong negotiating ploy with Steiner, they always hold it out as a possibility.

With profits expected to be around $1.60 per share next year, at $14 per share STNR trades at a very cheap 9x earnings. It has a strong balance sheet that is improving to the point of having no debt by mid-year 2004 and has begun to diversify its revenue base by expanding itself into the land-based “resort spa” segment. At these prices, with its history of adding real value to its cruise line partners, Steiner Leisure looks like a very attractive investment opportunity today.

Catalyst

With profits expected to be around $1.60 per share next year, at $14 per share STNR trades at a very cheap 9x earnings. It has a strong balance sheet that is improving to the point of having no debt by mid-year 2004 and has begun to diversify its revenue base by expanding itself into the land-based “resort spa” segment. At these prices, with its history of adding real value to its cruise line partners, Steiner Leisure looks like a very attractive investment opportunity today.